The Closing Bell
12/13/14
My number one grandson arrives today followed by my number two and four
granddaughters and number three grandson on Wednesday. I will attempt to post next week though it
could be sketchy; I know that I won’t be posting 12/29-1/4. Happy Holidays in advance.
Statistical Summary
Current Economic Forecast
2013
Real
Growth in Gross Domestic Product:
+1.0-+2.0
Inflation
(revised): 1.5-2.5
Growth
in Corporate Profits: 0-7%
2014
estimates
Real
Growth in Gross Domestic Product +1.5-+2.5
Inflation
(revised) 1.5-2.5
Corporate
Profits 5-10%
2015
estimates
Real
Growth in Gross Domestic Product +2.0-+3.0
Inflation
(revised) 1.5-2.5
Corporate
Profits 5-10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 16211-18957
Intermediate Term Uptrend 16191-21156
Long Term Uptrend 5369-18960
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1870-2234
Intermediate
Term Uptrend 1712-2425
Long Term Uptrend 783-2071
2013 Year End Fair Value 1430-1450
2014 Year End Fair Value
1470-1490
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 47%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 49%
Economics/Politics
The
economy is a modest positive for Your Money. There
wasn’t much by way of US economic data this week, but what we got was mostly to
the plus side: positives---weekly purchase and purchase applications, November retail
sales, November PPI, November small business optimism, consumer sentiment and
the November US budget deficit; negatives---October business inventories and
sales; neutral---weekly retail sales, weekly jobless claims and October
wholesale inventories and sales.
This week’s most
important number was the one primary indicator (retail sales) which appeared very
strong. I caution that there was a huge
seasonal adjustment factor calculated into the final figure which makes
revisions more likely. Nonetheless, in the
current environment, I will take any positive that I can get.
These upbeat
stats are made even more so by the fact that the US economy continues to fight
off the effects of an otherwise slowing global economy. Speaking of which, the numbers from overseas are
not getting any better (see below). So, our outlook remains the same, and the
primary risk (the spillover of a global economic slowdown) remains just so.
Our forecast:
‘a below average secular rate of recovery
resulting from too much government spending, too much government debt to
service, too much government regulation, a financial system with an impaired
balance sheet, and a business community unwilling to hire and invest because
the aforementioned, the weakening in the global economic outlook, along with......
the historic inability of the Fed to properly time the reversal of a vastly over
expansive monetary policy.’
The pluses:
(1)
our improving energy picture. The US
This week the
realization that lower oil prices [which we got in spades] were not an
unmitigated positive seems to have sunk into investor consciousness. It was
helped, of course, by terrible overseas macroeconomic data as well as specific
problems in Ukraine and Norway [both economies heavily dependent on oil]. The primary concern at the moment is the
extent of bank lending to the oil industry in particular the sub prime market
[why does this sound familiar?]
So it seems
that oil prices may have hit that crossover point about which I have been
concerned. I am not going to switch this
factor from a positive to a negative just yet; but if the evidence continues to
develop as it has this week, it is not far off.
Counterpoint
(medium):
The
negatives:
(1) a
vulnerable global banking system. What do you do with a bunch of habitual
crooks? My answer is make it more
painful to commit crimes---like throw the lot of them in jail. Otherwise, the same ol’ shit is just going to
keep happening:
[a] the IRS
accused Deutschebank of failing to pay $190 million in taxes,
[b] bank regulators
told JP Morgan that it was $22 billion short in its capital account,
[c] and the
clincher, Deutschebank and Barclays were accused of using algorithms to rig the
futures market---after all how do you fine an algorithm or send it to jail,
[d] OK, it
wasn’t the clincher. This is the clincher---the
bought and paid for GOP placed an amendment in the budget bill that negates a
provision of Dodd Frank that forced the banks to divest a segment of their
derivative trading operations {meaning you and I remain on the hook if
something goes wrong---which is all but inevitable.}
‘My concern here.....that: [a] investors ultimately
lose confidence in our financial institutions and refuse to invest in America and
[b] the recent scandals are simply signs that our banks are not as sound and
well managed as we have been led to believe and, hence, are highly vulnerable
to future shocks, particularly a collapse of the EU financial system.’
(2) fiscal
policy. Congress passed the FY2015 budget with more difficulty than I had
originally supposed---and for good reasons. The house leadership [the republicans]:
[a] allowed a
provision to be slipped into the budget bill that enables bank to hold on to
their derivative trading operations.
Just to reminder you, Dodd Frank was enacted with the purpose of
avoiding disasters such as occurred in 2007/2008 in the banking industry. One of those purposes was to reduce the
incentive of traders to make big, risky bets which the taxpayer was ultimately
on the hook for. This action is in
direct conflict with that purpose,
[b] also accepted
over 1000 earmarks in the bill,
[c] and
finally, presented the 1600 page bill to the full house with less than three days’
notice prior to the scheduled vote.
Remember all righteous indignant criticism of the dems when they posted
a bill with little notification?
Unfortunately,
it would appear, at least at first blush, that the election simply replaced one
group of self-interested politicians with another; and that the prospects for
real fiscal, tax and regulatory reform are not as promising as I may have hoped.
And Powerline:
Nonetheless,
avoiding a government shutdown and keeping spending roughly flat are positives
in themselves---the latter keeping the Federal budget shrinking as tax revenues
increase, the benefits of which are less usurpation of national income
[resources] by the government and less [more] reason for a tax increase [cut].
(3) the
potential negative impact of central bank money printing: The
key point here is that [a] the Fed has inflated bank reserves far beyond any
comparable level in history and [b] while this hasn’t been an economic problem
to date, {i} it still has to withdraw all those reserves from the system
without creating any disruptions---a task that I regularly point out it has
proven inept at in the past and {ii} it has created or is creating asset bubbles
in the stock market as well as in the auto, student and mortgage loan
markets.
This week there
were mixed messages from several quarters:
[a] an internal
ECB memo was leaked that suggested that Draghi has lost his voting majority on
the board and the promised 2015 QE was on indefinite Hold. On the other hand, a member of that board
swore up and down that QE was coming. I have no clue which to believe; but
clearly there is internal dissention that calls into question the likelihood of
an EU QE.
In another
matter, the ECB ran a second round of TLTRO {three year asset re-purchase
agreements from banks} which was a disappointment. In other words, the banks either don’t have
enough quality assets to participate in the program {impaired balance sheets}
or they don’t feel the need for more liquidity {no loan demand}.
[b] the Bank of
China first raised margin requirement and banks raised the time deposit rates {tightening},
then the BOC injected reserves into the banking system {easing}. As with the ECB, I don’t know exactly what to
make of these seemingly conflicting actions except that it shows that a massive
QE out of China is not a sure thing.
(3)
geopolitical risks. Relative quiet this week although [a] OPEC’s
{the Saudi’s} decision to not cut production could have potentially significant
implications if the cash flow negative members of OPEC get desperate and [b]
the US is sending additional arms to NATO members bordering Russia. Plus the
Ukraine government invited Russian ‘specialists’ in to help stabilize the
country {what could possibly go wrong here?}. Despite this comparative calm,
this is the source of a potential exogenous factor that could produce the
loudest bang.
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The economic events from the
rest of the world continued to get worse this week: the German trade numbers
were below expectations; UK industrial production was down; Japanese consumer
confidence fell; Ukraine needs almost twice as large a bailout as originally
estimated; in response to the economic damage to its economy wrought by lower
oil prices, Norway’s central bank lowered interest rates; Moody’s downgraded
France’s credit rating and Greece is undergoing a political crisis that could
lead to a default or withdrawal from the EU.
‘I have no idea when, as and if the rest of
the globe’s worsening economic straits will ever wash on to our shores; but I
do know that there is a clear risk of it happening; so this remains the biggest
risk to our forecast.’
Bottom line: the US economic news continued to improve last
week and accomplished it while avoiding any negative fallout from a slowing world
economy---which only got worse.
The QE advocates
received some bad news this week as (1) China implement a host of new policies
that both eased and tightened various components of monetary policy. While it may continue to provide some easing,
it appears that it won’t be joining the QE free for all, and (2) the ECB put
out its own set of mixed signals, the most significant of which as a leaked
internal memo that Draghi had lost his voting majority on the board and QE was
being postponed indefinitely.
Falling oil
prices were the principal headline this week which seems to have changed
perceptions from it being an unmitigated positive to a more balance view that some
economic sectors aside more oil could also suffer and perhaps more important
that a credit crisis is possible stemming from defaults on loans to the energy
industry.
This week’s
data:
(1)
housing: weekly mortgage applications and purchase
applications were up,
(2)
consumer: weekly
retail sales were mixed; November retail sales were well ahead of estimates,
however, ex autos and gas, they were only slightly better than anticipated;
weekly jobless claims fell fractionally,
(3)
industry: October wholesale inventories were up
solidly, but sales increased only half as much; October business inventories
were up but short of forecasts and sales decline 0.1%; the November small
business optimism index was better than expected; the preliminary December
reading for consumer sentiment was well above consensus,
(4)
macroeconomic: the November US budget deficit was
considerably lower than estimates; November PPI was lower than anticipated.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17280, S&P 2002) had a rough week but nonetheless closed
within uptrends across all timeframes: short term (16211-18957, 1870-2234),
intermediate term (16191-21456, 1712-2428) and long term (5369-18860,
783-2071). In fact, they remain a good
distance from any of their lower boundaries.
So the current decline could continue without jeopardizing any of the
major trends.
That
is not to say that there are no support levels closer in that can give us a
reading on the Market. (1) at the moment,
both the Dow and S&P are very close to their 50 day moving averages, (2) as
fate would have it, the former resistance high [now support] on the Dow
coincides almost exactly with its 50 day moving average. So for the Dow, it is right at an important
double support level, (3) the S&P’s next line of defense is its 200 day
moving average which currently is circa 1944 and finally (4) the last support
level before hitting the lower boundaries of their short term uptrends is [a]
the 200 day moving average for the Dow {circa 16838} and for the S&P, its
former resistance high {now support---1902}.
The Market’s
late December trading pattern (short):
Volume rose on
Friday; breadth deteriorated. The VIX jumped another 5%, closing within a short
term trading range, an intermediate term downtrend and above its 50 day moving
average. So far, it had remained within
a much longer term trading range. Any
violation of that trend could spell trouble.
This
indicator suggests that the bull market is not over (medium):
The long
Treasury moved up strongly again. It
closed above the upper of its intermediate term trading range for the third
day; if it holds that level through the close on Monday, the trend will re-set
to up. In the meantime, it remained
within very short term and short term uptrends and above its 50 day moving
average.
Pay attention to
junk bonds (short):
GLD was up on
Friday, closing within a very short term uptrend, a short term trading range,
an intermediate term downtrend, a long term trading range and above its 50 day
moving average.
Bottom line: the
Averages retreated this week, with the S&P bouncing off the upper boundary
of its long term uptrend. As unnerving
as some of the trading was, there remains quite a distance from current levels
and the lower boundaries of any uptrends.
So at least for the moment, this correction is nothing more than a pause
that refreshes. That said the VIX is
getting close to pushing above a year plus trading range, TLT is yelling that
something is awry somewhere and GLD is supporting it. So it is too soon to head for the hills but
time to be careful.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17280)
finished this week about 45.2% above Fair Value (11900) while the S&P (2002)
closed 35.2% overvalued (1480). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal
policy under control, a botched Fed transition from easy to tight money, a
historically low long term secular growth rate of the economy and a ‘muddle
through’ scenario in Europe, Japan and China.
Despite getting
only a trickle of economic data this week, what was reported was mostly
positive. That keeps our forecast on
track and, hence, the positive economic numbers in our Valuation Model
unchanged.
In addition, the
economy remains immune to the poor performance of virtually all of our major
trading partners. Given current
valuation levels, investors clearly believe that our economy can continue to
avoid the fallout of a global slowdown.
They may be correct, but I believe the risk of this not happening is
sufficient to make it the number one risk now facing both the economy and the
Market.
Another Market risk is the potential that
QEInfinity could be over much sooner than expected. I noted above the confusing signals from both
the ECB and the Bank of China---not that QE won’t occur in their economies, but
the risk of it not happening looks to be increasing. Not to be forgotten is the upcoming Japanese
elections (Sunday) in which Abe’s economic policies will be on trial. I can’t understand why the electorate would
endorse what can only be described as destructive policies; but the latest
polls suggest otherwise. Nonetheless,
the ousting of Abe (and his triple down, balls to wall QE) could trigger some
serious re-evaluation of the QEInfinity mindset.
Oil (prices) remained
the biggest economic factor in investors’ minds this week. As I noted above, the general perception has
gone from it ‘being an unmitigated positive to a much more balanced view’. The wild card here lies with the magnitude of
subprime debt that has been incurred in order to finance the enormous pick up
in exploration and production spending.
The negative thesis being that a continuing decline in oil prices will
render many current and planned projects uneconomic, reducing oil companies
free cash flow and, hence, their ability to service that debt and thus lead to
defaults and possibly another credit crisis.
There are a lot if’s in that thesis; but the point is that lower oil
prices are no longer being viewed as the greatest thing since sliced bread.
http://www.nakedcapitalism.com/2014/12/ilargi-will-the-oil-collapse-kill-energy-junk-bonds.html
(must read)
Overriding all of these considerations is
the cold hard fact that stocks are considerably overvalued not just in our Model
but with numerous other historical measures which I have documented at
length. This overvaluation is of such a
magnitude that it almost doesn’t matter what occurs fundamentally, because
there is virtually no improvement in the current scenario (improved economic
growth, responsible fiscal policy, successful monetary policy transition) that
gets valuations to Friday’s closing price levels.
Bottom line: the
assumptions in our Economic Model haven’t changed though our global ‘muddle
through’ scenario is at risk and lower oil prices have suddenly developed a
dark underside. The assumptions in our
Valuation Model have not changed either.
I remain confident in the Fair Values calculated---meaning that stocks
are overvalued. So our Portfolios
maintain their above average cash position.
Any move to higher levels would encourage more trimming of their equity
positions.
I
can’t emphasize strongly enough that I believe that the key investment strategy
today is to take advantage of the current high prices to sell any stock that
has been a disappointment or no longer fits your investment criteria and to
trim the holding of any stock that has doubled or more in price.
Bear
in mind, this is not a recommendation to run for the hills. Our Portfolios are still 55-60% invested and
their cash position is a function of individual stocks either hitting their
Sell Half Prices or their underlying company failing to meet the requisite
minimum financial criteria needed for inclusion in our Universe.
All
of my above negative commentary aside, I am amazed at how much damage had been
done to the oil stocks while the rest of the Market remains near highs. Indeed, the valuations of many of the oil
stocks in our Universe are either in or within shouting distance of their Buy
Value Ranges---which is to say, valued at bear market levels. Usually, poor performing sectors will
anticipate a similar move by stocks in general but the divergence that we are
now witnessing is nothing like I have seen before. My conclusion is that it is probably time to
nibble but only at the very best quality oil stocks (CVX, XOM) and only a
little, leaving room to average down if the shit hits the fan.
Accordingly,
at the open Monday morning, the Dividend Growth and High Yield Portfolios will
Add to their XOM holdings.
Contrarians
take note (short):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 12/31/14 11900 1480
Close this week 17280
2002
Over Valuation vs. 12/31 Close
5% overvalued 12495 1554
10%
overvalued 13090 1628
15%
overvalued 13685 1702
20%
overvalued 14280 1776
25%
overvalued 14875 1850
30%
overvalued 15470 1924
35%
overvalued 16065 1998
40%
overvalued 16660 2072
45%overvalued 17255 2146
50%overvalued 17850 2220
Under Valuation vs. 12/31 Close
5%
undervalued 11305 1406
10%undervalued 10710
1332 15%undervalued 10115 1258
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US
economy not the near term cyclical
influences. The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years with
somewhat higher inflation.
The Portfolios and Buy Lists are
up to date.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 40 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment
banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock
Investments, Steve hopes that his experience can help other investors build
their wealth while avoiding tough lessons that he learned the hard way.
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